Europe’s car sales have been staggering but where does Volkswagen stand?

Today’s press release from the European Automobile Manufacturers Association (ECEA) makes for fantastic reading. March car sales across the European Union in March were staggering, rising +6% YoY, marking the 31st consecutive month of growth. As the report itself states, this is close to March 2007 levels, just before the financial crisis hit. Across the European Union, strength looks broad based, as shown below:

Particular highlights include Cyprus +37.1%, Portugal +31.8%, Italy +17.4%, Ireland +13.7%, France +7.5% and the UK +5.26%. Some of these countries have had significant unemployment issues since the crisis, which has smashed consumer confidence. So this report speaks to a big improvement in consumer confidence across some of the most impacted countries, confirming the positive signs in loan growth that Felipe talked about a few weeks ago, in loan growth continues to recover. Combined with recent additional policy action from Mario Draghi, the outlook for Europe overall is now better than it has been for many years.

Delving into the report in a bit more detail, what really caught our eye was VW Group sales:

Whilst the group overall had sales growth of +2.6%, the core VW brand itself saw a decline of -1.64%. VW was the only major manufacturer (defined here as having a market share of 5% or greater) that saw sales fall. Every other manufacturer saw their major brands rise, and rise strongly, averaging +6%. The detail here is interesting, as within the VW group, Audi, Skoda and Others (including Bentley, Lamborghini and Bugatti) all rose strongly. In terms of market share, the VW core brand has lost 100bp, falling from 12.0% to 11.0% in the last year. It does appear from this data that the core VW brand has been damaged by the emissions scandal last year.

VW is a name that comes up frequently in conversations I have with our investors – as I have never owned it, and it widened significantly after the emissions scandal – so why do we still not own the bonds?

Above I’ve plotted three example bonds here from Volkswagen, all in EUR. The Blue line shows one of their shorter dated senior bonds, the 2% of 2020, which has recovered significantly from the initial widening following the emissions scandal story breaking. The red line shows a longer dated 3.3% of 2033 senior bond, which has rallied a little, but certainly is not back to pre-scandal levels. Looking at the green line, which is one of their hybrid bonds, the 3.5% 2030, it has remained volatile and is still near the wides. So is it wide enough to offer value?

In an absolute sense, anything BBB rated in Euros with a spread of 550bp and a yield of 5.75% should catch an investor’s eye. But what the spread and yield do not show you, but which our Observatory system does, is the horrendous cash price volatility of this bond. With a standard deviation of 19.6% over the last year, that volatility of this bond just does not stack up – even with an attractive yield. In fact, looking at our modified Sharpe Ratio measure, the score of 0.197 tells you all you need to know: you are simply not being compensated nearly enough in terms of yield for the volatility you have suffered and are likely to suffer going forward (we generally like to see Sharpe Ratios above 1.0). In fact, the senior VW bonds have even poorer modified Sharpe Ratios of 0.142 and 0.160 respectively – so unless you believe significant spread compression is likely with VW, these bonds are very hard to justify owning in any risk-adjusted sense.

With VW earnings coming out later this month, amidst the backdrop of declining market share and falling absolute sales compared to peers who are growing their sales and market shares (let alone further disclosure on rectification costs, litigation etc.), it is hard for us to get near term bullish on the name, despite optically attractive yields.